Michelle Napoli is editor of Net Lease forum, from which this article is excerpted.

New York City—A generally optimistic outlook prevailed at last week's RealShare Net Lease conference, where many speakers speculated that cap rates are at or close to the bottom and better buy-and-hold opportunities are ahead in the net lease property market."Deal volume is deal volume--it's lumpy," said W.P. Carey & Co. president and CEO Gordon DuGan, speaking on the "Town Hall Meeting" panel. While he acknowledged the market is still competitive, DuGan also said it has "seen a bottoming of cap rate compression, which bodes well for volume this year."

Another Town Hall Meeting panelist, Bruce MacDonald, president of Net Lease Capital Advisors, said, "What we felt so good about last year, from an acquisition standpoint, is that for the first time it wasn't a pedal-to-the-metal sellers' market."

The fifth annual RealShare Net Lease, produced by Real Estate Media, publisher of NET LEASE forum, was held at the Marriott Marquis in New York City. Aside from the general optimism, it was clear from speakers that the net lease market is still awash with capital, though that too may be beginning to subside. One strategy some investors are using as a result of the increased competition is to focus on less than investment grade tenant deals. It is a less crowded space that can result in better yields, but also requires more expertise in credit, said Gordon Whiting, managing director of Angelo, Gordon & Co., which recently launched its first net lease property fund.

"Because there's so much capital out there, people are paying these ridiculous prices," said Whiting, speaking on the "New Capital Sources, New Perspectives" panel. "That said, there are definitely fewer people than there were a year ago."

"The world is awash with capital and people are trying to place it as best they can," said fellow panelist Stephen Olsen, managing director of Prescott GNLP Capital LLC. He sees the net lease property investment market moving back to fundamentals, which he said are only going to get better. "The fundamentals are strong. What's going to drive cap rates and drive volume? It's not about fundamentals, it's about capital."

W. Kyle Gore, managing director of RBS Greenwich Capital, said he sees fewer sale-leasebacks, particularly in the retail sector, on the supply side, but more buyers on the demand side, especially fueled by 1031 investors. "I think there's more capital and a static number of deals, contrary to what many people think," he said while being interviewed by CRIC Capital LLC president and CEO Ethan Nessen during the "Net Lease Insider" presentation. As a result, Gore added, he's seeing deals done "in towns where Greyhound doesn't go to."

One specific type of capital discussed at the conference was private equity. During the "Net Lease Market Fact or Fiction" session featuring Mesirow Financial senior managing director Gerald Levin and Paul McDowell, CEO of Capital Lease Funding LLC, McDowell noted that private equity is generally more competitive than REITs. That is a result of leverage being viewed as a negative in the public markets but a positive in the private markets, and the use of leverage allowing a buyer to boost returns, he added.

Private equity is not likely to swallow all net lease REITs, Levin and McDowell agreed. Single-tenant REITs have been lagging REITs more generally, he noted, "for reasons I'm not sure why."

That fact was not lost on Gore, who during his "Net Lease Insider" interview was asked what he would do if he was given carte blanche with $1 billion. "There clearly are some net lease REITs out there that should be bought," he said, given the difference in their actual value vs. how the stock market is valuing them. His other ideas: find an opportunity to buy a large portfolio and bust it up; buddy up with mid-sized private equity investors; and, finally, "play the same game as Lampert did with Kmart."

The 1031 exchange and the pool of buyers it represents was also a key topic throughout RealShare Net Lease. For the past several years, said Jeffrey Thomas, first vice president in CB Richard Ellis Group Inc.'s net lease property group, the main part of the buyer base he has worked with has been a California multifamily owner who has sold to a condo converter and is exchanging his holdings into a a passive ownership property with stable income.

Sitting beside him on "The Numbers Behind the Trends" panel, Jeff Rothbart, principal of Boulder Net Lease Funds, agreed that is a significant demographic driving net lease property acquisitions, adding that investment scenario has a significant impact on pricing, too, given the high prices and low cap rates California property owners sell for.

"I have this theory, that as California goes for the 1031 exchange, so does the rest of the country. I think it's that big of a driver," said the discussion's moderator, CRIC's Nessen, to the agreement of both Thomas and Rothbart. "I think it's an indicator of demand."

Thomas and Rothbart offered their opinions on the top three factors or market trends affecting the 1031 market. Thomas said interest rates first and foremost, followed by the level of activity in other property sector sales, particularly in the apartment and condo sector and specifically in the California markets, and then wild cards such as large portfolios that would add a significant amount of supply to the market at once. Supply-demand fundamentals topped Rothbart's list, followed by deal particulars such as how functional and new properties are, and interest rates.

The issue of taxes also came up during the "Town Hall Meeting" discussion earlier in the day, with panelist David Ledy, COO of U.S. Realty Advisors LLC suggesting that in light of the federal deficit and the costs of the war in Iraq, politicians "will look to raise taxes without raising taxes for" ordinary people. That, he added, is something the industry needs to be cognizant of.

DuGan agreed that the government will be looking to raises revenue, and suggested it could come through a change in capital gains tax treatment, particularly if a Democrat comes into the White House. "I wouldn't be surprised if the capital gains rate goes up," he said.

The day-long event also included a keynote address by Hans Nordby, director of US market research and forecasting for Property & Portfolio Research, and panel discussions titled "Lenders' Forum," "The Sale-Leaseback Market: Is a Surge of Product on Its Way?" and "Competing for 1031 $: Trends in the TIC & Small Net Lease Property Markets."

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Optimism Prevails for Net Lease Cap Rates

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